beyondbrics

The landmark unconventional gas deal that Ukraine signed with Royal Dutch Shell in Davos on Thursday is not just a boost to its hopes of reducing its energy dependency on Russia.

It could give a much-needed fillip to its investment climate.

There is a long way to go before Shell pumps in anything like the $10bn-plus figure that several Ukrainian officials have been throwing around in recent days. But even Shell’s $400m upfront investment commitment this year is a big deal in a country where total foreign direct investment flows in the two decades since the Soviet collapse have totalled just over $50bn.

As Tim Ash of Standard Bank notes, Ukraine will hope that Shell’s example will be the start of larger energy sector investments by foreign majors. According to the US Energy Information Administration, Ukraine boasts Europe’s third-largest shale gas deposits after Poland and France. But there are reasons for caution.

For it to become a multi-billion dollar investment, the Shell deal relies on the geology turning out to be as expected, and production to be commercially viable. By some estimates, Shell’s Yuzivska field could hold an enormous 4 trillion cubic metres of various types of natural gas and coalbed methane. But though the depth of shale varies in eastern Europe, the deposits are generally deeper than most current shale gas production in North America, and can be trickier to crack.

In Poland, ExxonMobil withdrew last year after getting poor results from test wells, and a Polish agency slashed the estimate of its shale reserves.

While Ukraine’s government seems fully behind the shale push, some regions are less enthusiastic, amid concerns over the environmental impact of hydraulic “fracking”.

Shell had its deal approved by the Donetsk and Kharkiv regions in which the Yuzivska field is located. But Chevron, which last year won a tender to explore the Olesska resource in regions the European Union, is facing much tougher local opposition.

But energy companies have long been prepared to go into countries and situations that other companies would avoid. As Maplecroft, a political risk consultancy, notes in a Ukraine country risk report: “As with the wider business environment in Ukraine, the operational challenges associated with investment in the country’s burgeoning shale gas sector remain problematic and characterised by a high degree of uncertainty.”

So the Shell deal is unlikely to bring in large numbers of non-energy investments in its wake, without significant efforts to reduce corruption and strengthen the regulatory framework – long promised, but never delivered.

What could alter the investment environment, however, is if reduced reliance on Russian gas imports – thanks to the Shell deal and others – frees Ukraine to integrate more closely with the European Union. And that means signing a long-awaited free trade and political cooperation deal.

Foreign trade officials in Kiev suggest quite a few foreign companies are poised to invest into Ukraine’s agri-business and food processing industry, for example – if only it would sign the trade deal, allowing them to export freely into the EU single market.

For now, with what is seen as the politically-motivated jailing of ex-premier Yulia Tymoshenko still a huge sticking point between the two sides, that seems a distant prospect. But the Shell deal could yet prove a first step in shifting the political balance.

Related reading:
Ukraine to sign landmark shale gas deal, FT
Ukraine gas deal loosens Russia’s grip, FT
Erste: latest EU bank to dump Ukraine, beyondbrics
Ukraine’s government: it gets worse, beyondbrics